FACTORING AND TECHNOLOGY: Managing knowledge intensive factoring business

Feature

posted 9 Jan 2002 in Volume 5 Issue 6

FACTORING AND TECHNOLOGY: Managing knowledge intensive factoring business

Choose your technology products wisely is the message from SK Amarnath Senior Manager at ICICI Infotech Services Limited in Mumbai India. Here he looks at factoring in particular and the need for the right technology.

Factoring is popularly understood in the working capital management space as being a specialised product involving the packaging of finance and services variants. The providers and beneficiaries of this product include banks financing institutions as well as the sellers and buyers of goods and services. As a banking and financial services-orientated product it can be appreciated that factoring is a highly knowledge-based and service-oriented business. Therefore reliable and timely market intelligence together with flexibility to process transactions with ever increasing complexity are of critical importance. The goal of the provider of the product is to strategically deploy and leverage a right information technology resource that together with their other added value services allows them to deliver that competitive edge. Whereas experience has shown that all too often it is felt that the technology resource falls short of delivering the ultimate business requirements thereby delivering an often compromised product.

Traditionally technology is seen as being a tool to automate operational processes and to improve efficiency. While there is no denying the importance of operational efficiencies knowledge and service-based businesses and products are becoming increasingly complex and the demands now go beyond operational aspects thus placing a greater reliance on technology in being able to adapt and support these added business requirements. These requirements encompass areas such as improved risk management tools to assist in the decision making process a more customer centric focus the ability to support the full life cycle of a transaction and so on. The reasons for the often perceived failure of technology not being able to deliver may be found from both the providers of the technology as well as the users. The standards set by the technology providers need not always be taken as the best or appropriate for the underlying business need. Gaps can also be found in technology in terms of their skewed orientation towards the operational issues as opposed to keeping pace with the market and business demands. Equally true is the softer demands made by the users of technology resource. These can range from the lack of understanding of the full potential of the available technology resource unclear business definitions and even non-availability of the top management or the right people for taking strategic decisions on the use of the technology resource.

Risk management and pricing

Factoring as a business domestically or internationally is heavily reliant on the ability to gather information from various sources and analysing the information to allow the business to decide and act accordingly. The gathering and analysing of information is the key to the successful ability to accurately price products and manage the risks. Consequently inadequacies in this process can also have a far reaching adverse effect to the business.

Experience has also shown that heavy reliance is placed upon experienced professionals to provide their subjective judgment of the situation to give vital input into the decision process of pricing and risk management. However with the growth of business volumes and product complexities this can only result on even further dependency being placed upon the experienced professionals who may well fall short of keeping pace with demand. The ability to fine tune the subjective decision processes offers an additional challenge to the business in providing that competitive edge.

‘Every person is good. Every person is not good all the time’. A corporate transaction is not very different. Good because otherwise there was no deal between the factoring institution and the corporate. However quality of goodness is not absolute. It is variable over time and so is the risk. It is important to keep measuring the goodness or the risk and refine the decisions on every single deal. Hence the critical need to institutionalise the knowledge base of the experienced bankers and financiers within the factoring institution and around the world. To help business growth it is essential both to guide the larger community of managers to take finer decisions independently as well as enrich back the experience and knowledge base to benefit further on a continuous basis.

Risk perceptions

The faster the working capital lock-in is converted into cash for reinvestment and profit booking the more efficient and liquid a business becomes. Working capital financiers encourage businesses that are more efficient and liquid compared to those that have higher risk with a longer working capital life cycle. Factoring as a concept operates in the part of the working capital cycle wherein it converts the open account receivable into cash by purchasing the debts. (Factoring of debts can also be for collection services and these features are kept out of the purview of this article.)

Factoring institutions also enable the corporate business to outsource non-core activities like sales-ledger maintenance and so on. This enables the corporate business to exit working capital cycle in advance releasing the funds locked-in besides bringing in efficiency in overall resources utilisation.

While working capital financing is of a broader scope ‘close to cash’ status within the working capital life-cycle is more desirable in working capital financing. However as we have experienced traditional working capital financing does not always pass on the benefit of this transition of risks within the working capital life cycle to the borrower. It is also experienced that working capital financiers may not always differentiate their pricing and risk management methodologies between financing raw material work-in-progress finished goods and receivable (open account).

The result can often be indifferent pricing or any benefit not being offered to the clients (sellers of goods and services) either because working capital financiers may choose not to do so or more importantly they simply do not have the tools available to them to monitor and track such benefits. Factoring practised with the right technology can be used as a tool to allow the capital financier to differentiate these risks and accordingly price the same for the benefit of the businesses.

Finer pricing

Having differentiated the movement of risks within the working capital space the challenge to the factoring institutions is the need to further differentiate the risks offered by the ‘close to cash’ zones in relation to different corporate deals. These risks are dynamic and change over time hence the need to also respond on a dynamic basis.

Let us take some simple examples. Say in a factoring business transaction ‘A’ between a client and customer (the buyer of goods and services) ‘A’ that is expected to be paid in 30 days and another transaction ‘B’ between the client and customer ‘B’ that is assumed to be paid in 50 days needs to be differentiated and priced accordingly. Further these credit periods practiced by the above customers may vary over time say one year later customer ‘A’ may be taking 40 days but the customer ‘B’ may take 25 days to honor the payment of debts. There is a need to recognise these movements of risks and price accordingly.

It is also true that customer ‘A’ who is expected to take 30 days (and priced accordingly) for payment may actually take 45 days whereas customer ‘B’ who is expected to pay in 50 days (and priced accordingly) does honour the payment on date. While upfront customer ‘B’ is treated as relatively risky it actually turns out to be that customer ‘A’ is more risky as it offers more uncertainty. It is very essential to track this real life performance of the business and refine the decisions continuously.

Factoring institutions that do not monitor track and build an historic profile and trend analysis of its business cashflows could find that the high risk business is being subsidised to the detriment of less riskier business. Through the use of technology to provide improved monitoring techniques and early warning indicators factoring institutions can now look beyond the traditional dependence on the annual reports of the companies information from the credit rating agencies secondary sources and even the time tested subjective views on the businesses to provide them with the better pricing and risk management tools.

Market intelligence

Market intelligence is understood and used by players in the banking and financial services industry corporate system in many different ways. While product pricing by the seller has to factor the real credit period and associated risk with regard to the buyer(s) a financially disciplined buyer with sound vendor policy practice will demand finer commercial terms from their business associates. From the factoring institution’s perspective there is a compelling need to differentiate the deals of the seller with the buyers having varied vendor policies and financial disciplines. This added perspective of ‘vendor policy practice’ offers a further challenge to the players in the market in their ability to tracking and conducting business.

Ever growing competition in the market place demands finer terms from sellers. This cannot be handled effectively without adequate and timely market intelligence on the latest ‘vendor policy practice’ and financial risks associated with these transactions. Additionally factoring institutions cannot support demand on back-to-back basis without the same adequate and timely market intelligence to support their own decision process.

Structured transactions – market focus

Today’s competitive and complex corporate business brings enormous challenges to factoring institutions not only in terms of speedy turnaround of financing requirements but also in their ability to provide and support case specific and tailor made deals.

The demands may vary based on their competitive position in the market or even guided by the specific performance of the industry of the corporate or its specific sales promotion strategy. The features of the transactions may also vary widely from simple variants to complex algorithms. Factoring institutions that equip themselves in a proactive manner to support these requirements will see their business growing. While it can be safely assumed that the factoring institution has many of the resources available to them including human financial infrastructure and so on lack of customer focus in the deployment of technology often leads to a rough path for the business.

Reasons for this may be many including the fact that the technology systems will and always will trail the commercial business but it is also true that the business apply a greater focus its technology strategy. In light of this it is of critical importance that the technology deployment strategy is futuristic and enables the factoring institutions to complete support and service the full life cycle of structured transactions that are dynamic and ever changing.

Strategising technology

The ability and use of technology as a resource is often underestimated. It was perfectly all right as long as technology was considered as a tool to automate processes and address operational issues. However with the evolution of business complexities and competition it is only natural that the business should and will place greater demands on the various resources be they human financial or other but more importantly technology cannot be counted out.

In line with the business evolution it is of increasing importance to deploy technology that offers cutting edge competitiveness to the factoring institution. It is essential to look for certain critical features in the technology including:

Risk oriented of the finest nature. The technology should have been conceived to identify various risk elements of the business categorise and differentiate and offer matured analysis to price the risks competitively. For example a particular transaction pertaining to a seller and a buyer based on the credit scoring of the buyer may be done. However in case of factoring if the buyer does not practice the best of the vendor policy in terms of actual payments towards its debts the technology should track these shortfalls dynamically and over a time horizon and accordingly assist downgrading the credit scoring internally and revisit the pricing accordingly. On the other hand if another buyer who is not so well rated but follows superior vendor policies then they should benefit accordingly.

Self-learning. The technology deployment should be oriented to institutionalise the collective knowledge base of the factoring institution. The subjective and perception based decisions should be refined over a period of time in the organisation. The technology should assist the line managers to take finer decisions based on actual facts and more such decisions and experiences should be brought back by the technology to refine the knowledge base further.

Market focused. The technology should smoothly aid full cycle tailor made solutions offered by the factoring institutions to their clients.

It is essential that top management of factoring institutions as well as end users are involved in identifying and acquiring the right technology product. It should be ensured that vital market intelligence is provided for conducting the business effectively. Whereas both the users and the technology providers normally play down these softer but strategic features justifying them to be built in future which never comes.

In short demand more from this critical resource called technology!

Originally published in e-mmerce